As much as I want to believe otherwise, I don’t think the worst is over for global stock markets. Yes, recently (27 to 31 October) we saw the best week for the Dow in 34 years. It rose by 10.5%. But what does this mean?
It means that not since the week ending October 11, 1974, has the Dow risen so much in percentage terms. But let me remind you that October 1974 was not the low of the terrible 1973-74 bear market. Yes, it rose by a massive 14.1% that week in 1974, and ended the week at 658.17. But in the weeks to come, this would prove to be just another bear market rally. It would fall, ultimately, to a closing low of 577.60 on 6 December.
In fact, if we look at the best weeks ever on record for the Dow, we see that they were all bear market rallies. The week ending 26 June, 1931, saw the Dow soar by 16.1%, its best ever. But the absolute low was still over a year away. In fact, except for that week in 1974 and last week, all of the best 15 weeks of the Dow took place in the 1930s, and most were bear market rallies.
To convince me the lows are really in, I’d like to see a couple of things.
First, P/E ratios on the major index would have to be much lower. At great market bottoms of the past, they have been well under ten. And the dividend yield on the indices has been as high as 6% at great bottoms. Given current dividends on the Dow, it would have to go to around 5,300 in order to yield 6%.
I’m not predicting this will happen, because the Fed and other central banks are doing everything they can to inflate. But I realise they may not be successful…
So far, they have not been. Banks are still not lending and people are afraid to borrow. I fear to say this, but so far things are looking much like the beginning of the long Japanese deflation that began in the early 1990s and has still not ended. Just last week, the Japanese central bank once again cut interest rates to near zero and announced yet more spending programmes. All of these programmes and all of the printing of money since 1990 have not resulted in economic recovery. This is a sobering thought for the rest of the world.
For many of the countries now flirting with deflation, like the US, relatively few people have much in the way of savings. The idea that the average American family should have as little as eight months of expenses saved is greeted with laughter from most Americans.
“Who has that much?” many ask.
Yet I predict that – though it will be wrenching – Americans will be forced to save like they have not saved since the 1930s. This process will take years, and it may be the case that what has happened this year with both real estate and all other asset prices falling, we will see a new generation of savers in the US and much of the world.
I think this will be so even though we will see bargains in asset prices during the next few years. At some point, for instance, the world’s stock markets will be great bargains. Yet most people will be too scared to buy into them, having been fooled too many times before.
So… while the market could rally strongly from here, I’m not risking much of my capital on it. My strategy is still to build cash, but to look for bargains. When the valuations I just cited appear, I’ll be a big buyer of stocks.
• This article was written by Chris Weber for the free investment newsletter DailyWealth